The great inflations of our age are not acts of God. They are man-made or, to say it bluntly, government-made. They are the offshoots of doctrines that ascribe to governments the magic power of creating wealth out of nothing and of making people happy by raising the “national income.”

All proposals that aim to do away with the consequences of perverse economic and financial policy, merely by reforming the monetary and banking system, are fundamentally misconceived. Money is nothing but a medium of exchange and it completely fulfills its function when the exchange of goods and services is carried on more easily with its help than would be possible by means of barter. Attempts to carry out economic reforms from the monetary side can never amount to anything but an artificial stimulation of economic activity by an expansion of the circulation, and this, as must constantly be emphasized, must necessarily lead to crisis and depression. Recurring economic crises are nothing but the consequence of attempts, despite all the teachings of experience and all the warnings of the economists, to stimulate economic activity by means of additional credit.

Where the free exchange of goods and services is unknown, money is not wanted.

The phenomenon of money presupposes an economic order in which production is based on division of labor and in which private property consists not only in goods of the first order (consumption goods), but also in goods of higher orders (production goods).

The function of money is to facilitate the business of the market by acting as a common medium of exchange.

Credit transactions are in fact nothing but the exchange of present goods against future goods.

Although it is usual to speak of money as a measure of value and prices, the notion is entirely fallacious. So long as the subjective theory of value is accepted, this question of measurement cannot arise.

Acts of valuation are not susceptible of any kind of measurement.

But subjective valuation, which is the pivot of all economic activity, only arranges commodities in order of their significance; it does not measure this significance.

If it is impossible to measure subjective use-value, it follows directly that it is impracticable to ascribe “quantity” to it. We may say, the value of this commodity is greater than the value of that; but it is not permissible for us to assert, this commodity is worth so much.

Value is always the result of a process of valuation. The process of valuation compares the significance of two complexes of commodities from the point of view of the individual making the valuation. The individual making the valuation and the complexes of goods valued, that is, the subject and the objects of the valuation, must enter as indivisible elements into any given process of valuation.

There is no value outside the process of valuation. There is no such thing as abstract value. Total value can be spoken of only with reference to a particular instance of an individual or other valuing “subject” having to choose between the total available quantities of certain economic goods.

When an indirect exchange is transacted with the aid of money, it is not necessary for the money to change hands physically; a perfectly secure claim to an equivalent sum, payable on demand, may be transferred instead of the actual coins. In this by itself there is nothing remarkable or peculiar to money.

In the first place, money is especially well adapted to constitute the substance of a generic obligation.

Commodities can never become money just because the state commands it; money can be created only by the usage of those who take part in commercial transactions.

We may give the name commodity money to that sort of money that is at the same time a commercial commodity; and the name fiat money to money that comprises things with a special legal qualification. A third category may be called credit money, this being that sort of money which constitutes a claim against any physical or legal person.

In an economic system based on private ownership of the means of production, no government regulation can alter the terms of exchange except by altering the factors that determine them.

The concept of money as a creature of law and the state is clearly untenable. It is not justified by a single phenomenon of the market. To ascribe to the state the power of dictating the laws of exchange, is to ignore the fundamental principles of money-using society.

Business usage alone can transform a commodity into a common medium of exchange. It is not the state, but the common practice of all those who have dealings in the market, that creates money. It follows that state regulation attributing general power of debt liquidation to a commodity is unable of itself to make that commodity into money. If the state creates credit money—and this is naturally true in a still greater degree of fiat money—it can do so only by taking things that are already in circulation as money substitutes (that is, as perfectly secure and immediately convertible claims to money) and isolating them for purposes of valuation by depriving them of their essential characteristic of permanent convertibility. Commerce would always protect itself against any other method of introducing a government credit currency. The attempt to put credit money into circulation has never been successful, except when the coins or notes in question have already been in circulation as money substitutes. This is the limit of the constantly overestimated influence of the state on the monetary system. What the state can do in certain circumstances, by means of its position as controller of the mint, by means of its power of altering the character of money substitutes and depriving them of their standing as claims to money that are payable on demand, and above all by means of those financial resources which permit it to bear the cost of a change of currency, is to persuade commerce to abandon one sort of money and adopt another. That is all.

Production is quite possible without money. There is no need for money either in the isolated household or in the socialized community. Nowhere can we discover a good of the first order of which we could say that the use of money was a necessary condition of its production.

The loss of a consumption good or production good results in a loss of human satisfaction; it makes mankind poorer The gain of such a good results in an improvement of the human economic position; it makes mankind richer The same cannot be said of the loss or gain of money. Both changes in the available quantity of production goods or consumption goods and changes in the available quantity of money involve changes in values; but whereas the changes in the value of the production goods and consumption goods do not mitigate the loss or reduce the gain of satisfaction resulting from the changes in their quantity, the changes in the value of money are accommodated in such a way to the demand for it that, despite increases or decreases in its quantity, the economic position of mankind remains the same. An increase in the quantity of money can no more increase the welfare of the members of a community, than a diminution of it can decrease their welfare. Regarded from this point of view, those goods that are employed as money are indeed what Adam Smith called them, “dead stock, which ... produces nothing.”

We have shown that, under certain conditions, indirect exchange is a necessary phenomenon of the market. The circumstance that goods are desired and acquired in exchange not for their own sakes but only in order to be disposed of in further exchange can never disappear from our type of market dealing, because the conditions that make it inevitable are present in the overwhelming majority of all exchange transactions. Now the economic development of indirect exchange leads to the employment of a common medium of exchange, to the establishment and elaboration of the institution of money. Money, in fact, is indispensable in our economic order But as an economic good it is not a physical component of the social distributive apparatus in the way that account books, prisons, or firearms are. No part of the total result of production is dependent on the collaboration of money, even though the use of money may be one of the fundamental principles on which the economic order is based.

Production goods derive their value from that of their products. Not so money; for no increase in the welfare of the members of a society can result from the availability of an additional quantity of money. The laws which govern the value of money are different from those which govern the value of production goods and from those which govern the value of consumption goods. All that these have in common is their general underlying principle, the fundamental economic law of value. This is a complete justification of the suggestion put forward by Knies that economic goods should be divided into means of production, objects of consumption, and media of exchange; for, after all, the primary object of economic terminology is to facilitate investigation into the theory of value.

Of the two concepts of capital that Böhm-Bawerk distinguishes, following the traditional economic terminology, that of what is called private or acquisitive capital is both the older and the wider. This was the original root idea from which the narrower concept of social or productive capital was afterward separated. It is therefore logical to begin our investigation by inquiring into the connection between private capital and money.

Böhm-Bawerk defines private capital as the aggregate of the products that serve as a means to the acquisition of goods. It has never been questioned that money must be included in this category.

Money is an acquisitive instrument only when it is exchanged for some other economic good. In this respect money may be compared with those consumption goods that form part of private capital only because they are not consumed by their owners themselves but are used for the acquisition of other goods or services by means of exchange. Money is no more acquisitive capital than these consumption goods are; the real acquisitive capital consists in the goods for which the money or the consumption goods are exchanged. Money that is lying “idle,” that is, money that is not exchanged for other goods, is not a part of capital; it produces no fruit. Money is part of the private capital of an individual only if and so far as it constitutes a means by which the individual in question can obtain other capital goods.

It is not the task of the economist, but of the natural scientist, to explain why corn is useful to man and valued by him; but it is the task of the economist alone to explain the utility of money. Consideration of the subjective value of money without discussion of its objective exchange value is impossible. In contrast to commodities, money would never be used unless it had an objective exchange value or purchasing power. The subjective value of money always depends on the subjective value of the other economic goods that can be obtained in exchange for it. Its subjective value is in fact a derived concept. If we wish to estimate the significance that a given sum of money has, in view of the known dependence upon it of a certain satisfaction, we can do this only on the assumption that the money possesses a given objective exchange value. “The exchange value of money is the anticipated use-value of the things that can be obtained with it.” Whenever money is valued by anybody it is because he supposes it to have a certain purchasing power.

“The objective exchange value of goods is their objective significance in exchange, or, in other words, their capacity in given circumstances to procure a specific quantity of other goods as an equivalent in exchange.”8 It should be observed that even objective exchange value is not really a property of the goods themselves, bestowed on them by nature, for in the last resort it also is derived from the human process of valuing individual goods.

If the objective exchange value of a good is its power to command a certain quantity of other goods in exchange, its price is this actual quantity of other goods. It follows that the concepts of price and objective exchange value are by no means identical.

By “the objective exchange value of money” we are accordingly to understand the possibility of obtaining a certain quantity of other economic goods in exchange for a given quantity of money; and by “the price of money” this actual quantity of other goods. It is possible to express the exchange value of a unit of money in units of any other commodity and speak of the commodity price of money; but in actual life this phraseology and the concept it expresses are unknown. For nowadays money is the sole indicator of prices.

The theory of money must take account of the fundamental difference between the principles which govern the value of money and those which govern the value of commodities. In the theory of the value of commodities it is not necessary at first to pay any attention to objective exchange value. In this theory, all phenomena of value and price determination can be explained with subjective use-value as the starting point. It is otherwise in the theory of the value of money; for since money, in contrast to other goods, can fulfill its economic function only if it possesses objective exchange value, an investigation into its subjective value demands an investigation first into this objective exchange value. In other words, the theory of the value of money leads us back through subjective exchange value to objective exchange value.

And all that it is important to know about the objective use-value of money may be summed up in the one statement—it depends on the objective exchange value of money.

According to modern value theory, price is the resultant of the interaction in the market of subjective valuations of commodities and price goods. From beginning to end, it is the product of subjective valuations.

This law of price is just as valid for indirect as for direct exchange. The price of money, like other prices, is determined in the last resort by the subjective valuations of buyers and sellers. But, as has been said already, the subjective use-value of money, which coincides with its subjective exchange value, is nothing but the anticipated use-value of the things that are to be bought with it. The subjective value of money must be measured by the marginal utility of the goods for which the money can be exchanged.

It follows that a valuation of money is possible only on the assumption that the money has a certain objective exchange value. Such a point d’appui is necessary before the gap between satisfaction and “useless” money can be bridged. Since there is no direct connection between money as such and any human want, individuals can obtain an idea of its utility and consequently of its value only by assuming a definite purchasing power. But it is easy to see that this supposition cannot be anything but an expression of the exchange ratio ruling at the time in the market between the money and commodities.

Before an economic good begins to function as money it must already possess exchange value based on some other cause than its monetary function. But money that already functions as such may remain valuable even when the original source of its exchange value has ceased to exist. Its value then is based entirely on its function as common medium of exchange.

In the first place, it must be recognized that from the economic point of view there is no such thing as money lying idle. ..Th

e stock of money of the community is the sum of the stocks of individuals; there is no such thing as errant money, no money which even for a moment does not form part of somebody’s stock.

There has been no generation that has not grumbled about the “expensive times” that it lives in. But the fact that “everything” is becoming dearer simply means that the objective exchange value of money is falling.

The collection of “facts” is not science, by a long way. There are no grounds for ascribing authoritative significance to the opinions of businessmen; for economics, these opinions are nothing more than material, to be worked upon and evaluated.

The purchasing power of money is the same everywhere; only the commodities offered are not the same.

To recapitulate: the exchange ratio subsisting between commodities and money is everywhere the same. But men and their wants are not everywhere the same, and neither are commodities. Only if these distinctions are ignored is it possible to speak of local differences in the purchasing power of money or to say that living is dearer in one place than in another.

Money does not flow to the place where the rate of interest is highest; neither is it true that it is the richest nations that attract money to themselves.

Under certain conditions, index numbers may do very useful service as an aid to investigation into the history and statistics of prices; for the extension of the theory of the nature and value of money they are unfortunately not very important.

I

nflationism is that monetary policy that seeks to increase the quantity of money.

The assistance of inflation is invoked whenever a government is unwilling to increase taxation or unable to raise a loan; that is the truth of the matter The next step is to inquire why the two usual methods of raising money for public purposes cannot or will not be employed.

Inflation is taxation of ownership.

Taxation, it is true, becomes more burdensome as the value of money rises; but the greater part of the advantage of this is secured, not by the state, but by its creditors. Now policies favoring creditors at the expense of debtors have never been popular. Lenders of money have been held in odium, at all times and among all peoples.

Generally speaking, the class of persons who draw their income exclusively or largely from the interest on capital lent to others has not been particularly numerous or influential at any time in any country.

The Business of Banking

The business of banking falls into two distinct branches: the negotiation of credit through the loan of other people’s money and the granting of credit through the issue of fiduciary media, that is, notes and bank balances that are not covered by money.

The activity of the banks as negotiators of credit is characterized by the lending of other people’s, that is, of borrowed, money. Banks borrow money in order to lend it; the difference between the rate of interest that is paid to them and the rate that they pay, less their working expenses, constitutes their profit on this kind of transaction. Banking is negotiation between granters of credit and grantees of credit. Only those who lend the money of others are bankers; those who merely lend their own capital are capitalists, but not bankers.1 Our use of this definition of the Classical School should not furnish any ground for terminological controversy. The expression banking may be extended or contracted as one likes, although there seems little reason for departing from a terminology that has been usual since Smith and Ricardo. But one thing is essential: that activity of the banks that consists in lending other people’s money must be sharply distinguished from all other branches of their business and subjected to separate consideration.

For the activity of the banks as negotiators of credit the golden rule holds, that an organic connection must be created between the credit transactions and the debit transactions. The credit that the bank grants must correspond quantitatively and qualitatively to the credit that it takes up. More exactly expressed, “The date on which the bank’s obligations fall due must not precede the date on which its corresponding claims can be realized.” Only thus can the danger of insolvency be avoided. It is true that a risk remains. Imprudent granting of credit is bound to prove just as ruinous to a bank as to any other merchant. That follows from the legal structure of their business; there is no legal connection between their credit transactions and their debit transactions, and their obligation to pay back the money they have borrowed is not affected by the fate of their investments; the obligation continues even if the investments prove dead losses. But it is just the existence of this risk which makes it worthwhile for the bank to play the part of an intermediary between the granter of credit and the grantee of it. It is from the acceptance of this risk that the bank derives its profits and incurs its losses.

It is one of the most remarkable phenomena in the history of political economy that this fundamental distinction between notes and bills could have passed unnoticed. It raises an important problem for investigators into the history of economic theory. And in solving this problem it will be their principal task to show how the beginnings of a recognition of the true state of affairs that are to be found even in the writings of the Classical School and were further developed by the Currency School, were destroyed instead of being continued by the work of those who came after.

The fundamental error of the Banking School lies in its failure to understand the nature of the issue of fiduciary media.

If the banks-of-issue bring the rate of interest they charge in their creditor transactions near to the natural rate of interest, then the demands upon them decrease; if they reduce their rate of interest so that it falls lower than the natural rate of interest, then these demands increase. The cause of fluctuations in the demand for the credit of the banks-of-issue is to be sought nowhere else than in the credit policy they follow.

By virtue of the power at their disposal of granting bank credit through the issue of fiduciary media the banks are able to increase indefinitely the total quantity of money and money substitutes in circulation. By issuing fiduciary media, they can increase the stock of money in the broader sense in such a way that an increase in the demand for money which otherwise would lead to an increase in the objective value of money would have its effects on the determination of the value of money nullified. They can, by limiting the granting of loans, so reduce the quantity of money in the broader sense in circulation as to avoid a diminution of the objective exchange value of money which would otherwise occur for some reason or other In certain circumstances, as has been said, this may occur. But in all the mechanism of the granting of bank credit and in the whole manner in which fiduciary media are created and return again to the place whence they were issued, there is nothing which must necessarily lead to such a result.

T

he quantity of fiduciary media in circulation has no natural limits. If for any reason it is desired that it should be limited, then it must be limited by some sort of deliberate human intervention—that is by banking policy.

The requests made to the banks are requests, not for the transfer of money, but for the transfer of other economic goods. Would-be borrowers are in search of capital, not money. They are in search of capital in the form of money, because nothing other than power of disposal over money can offer them the possibility of being able to acquire in the market the real capital which is what they really want. Now the peculiar thing, which has been the source of one of the most difficult puzzles in economics for more than a hundred years, is that the would-be borrower’s demand for capital is satisfied by the banks through the issue of money substitutes. It is clear that this can only provide a provisional satisfaction of the demands for capital. The banks cannot evoke capital out of nothing. If the fiduciary media satisfy the desire for capital, that is if they really procure disposition over capital goods for the borrowers, then we must first seek the source from which this supply of capital comes. It will not be particularly difficult to discover it. If the fiduciary media are perfect substitutes for money and do all that money could do, if they add to the social stock of money in the broader sense, then their issue must be accompanied by appropriate effects on the exchange ratio between money and other economic goods. The cost of creating capital for borrowers of loans granted in fiduciary media is borne by those who are injured by the consequent variation in the objective exchange value of money; but the profit of the whole transaction goes not only to the borrowers, but also to those who issue the fiduciary media, although these admittedly have sometimes to share their gains with other economic agents, as when they hold interest-bearing deposits, or the state shares in their profits.

The entrepreneurs who approach banks for loans are suffering from shortage of capital; it is never shortage of money in the proper sense of the word that drives them to present their bills for discounting. In some circumstances this shortage of capital may be only temporary; in other circumstances it may be permanent. In the case of the many undertakings which constantly draw upon short-term bank credit, year in, year out, the shortage of capital is a permanent one.

Consequently the chief rule to be observed in the business of a credit-issuing bank is quite clear and simple: it must never issue more fiduciary media than will meet the requirements of its customers for their business with each other.

The expressions solvency and liquidity are not always used correctly when they are applied to the circumstances of a bank. They are sometimes regarded as synonymous; but orthodox opinion understands them to refer to two different states.

A bank may be said to be solvent when its assets are so constituted that a liquidation would necessarily result at least in complete satisfaction of all of its creditors. Liquidity is that condition of the bank’s assets which will enable it to meet all its liabilities, not merely in full, but also in time, that is, without being obliged to ask for anything in the nature of a moratorium from its creditors. Liquidity is a particular sort of solvency. Every enterprise—for the same is true of any body that participates in credit transactions—that is liquid is also solvent; but on the other hand not every undertaking that is solvent is also liquid. A person who cannot settle a debt on the day when it falls due has not a liquid status, even if there is no doubt that he will be able in three or six months’ time to pay the debt together with interest and the other costs in which the delay is meanwhile involving the creditor.

It is theoretically impossible to maintain the credit bank system in a state of liquidity. A simultaneous destruction of confidence in all banks would necessarily lead to a general collapse.

In lay circles this problem is regarded as long since solved. Money performs its function as a common medium of exchange in facilitating not only the sale of present goods but also the exchange of present goods for future goods and of future goods for present goods.

What is usually called plentifulness of money and scarcity of money is really plentifulness of capital and scarcity of capital. A real scarcity or plentifulness of money can never be directly perceptible in the community, that is, it can never make itself felt except through its influence on the objective exchange value of money and the consequences of the variations so induced. For since the utility of money depends exclusively upon its purchasing power, which must always be such that total demand and total supply coincide, the community is always in enjoyment of the maximum satisfaction that the use of money can yield.

Variations in the ratio between the stock of money and the demand for money must ultimately exert an influence on the rate of interest also; but this occurs in a different way from that popularly imagined. There is no direct connection between the rate of interest and the amount of money held by the individuals who participate in the transactions of the market; there is only an indirect connection operating in a roundabout way through the displacements in the social distribution of income and wealth which occur as a consequence of variations in the objective exchange value of money.

Generally speaking, individuals with large incomes make better provision for the future than individuals with small incomes. The smaller an individual’s income is, the greater is the premium which he sets on present goods in comparison with future goods. Conversely increased prosperity means increased provision for the future and higher valuation of future goods.

An increase in the stock of money in the broader sense caused by an issue of fiduciary media means a displacement of the social distribution of property in favor of the issuer. If the fiduciary media are issued by the banks, then this displacement is particularly favorable to the accumulation of capital, for in such a case the issuing body employs the additional wealth that it receives solely for productive purposes, whether directly by initiating and carrying through a process of production or indirectly by lending to producers. Thus, as a rule, the fall in the rate of interest in the loan market, which occurs as the most immediate consequence of the increase in the supply of present goods that is due to an issue of fiduciary media, must be in part permanent; that is, it will not be wiped out by the reaction that is afterward caused by the diminution of the property of other persons. There is a high degree of probability that extensive issues of fiduciary media by the banks represent a strong impulse toward the accumulation of capital and have consequently contributed to the fall in the rate of interest.

In fact it is obvious that however great the increase in the stock of money in the broader sense might be, whether it occurred by way of an increase in fiduciary media or by way of an increase in the stock of money in the narrower sense, the rate of interest could never be reduced to zero. That could take place only if the displacements that occurred increased the national subsistence fund to such an extent that all possibilities of increasing production by engaging in more productive “roundabout” methods of production were exhausted. This would mean that in all branches of production the time that elapsed between the commencement of production and the enjoyment of the product was not taken into consideration, and production was carried so far that the prices of the products were only just sufficient to pay an equal return to the primary factors in each employment. In particular, as far as very durable goods are concerned, this would mean that their quantity and durability would be tremendously increased, until the prices of their services fell so low that they would only just provide for the amortization of the investments.

It has already been shown that the circulation of fiduciary media is possible only on the assumption that the issuing bodies enjoy the full confidence of the public, since even the dawning of mistrust would immediately lead to a collapse of the house of cards that comprises the credit circulation. We know, furthermore, that all credit-issuing banks endeavor to extend their circulation of fiduciary media as much as possible, and that the only obstacles in their way nowadays are legal prescriptions and business customs concerning the covering of notes and deposits, not any resistance on the part of the public. If there were no artificial restriction of the credit system at all, and if the individual credit-issuing banks could agree to parallel procedure, then the complete cessation of the use of money would only be a question of time. It is, therefore, entirely justifiable to base our discussion on the above assumption.

There is only one efficacious way toward a rise in real wage rates and an improvement of the standard of living of the wage earners: to increase the per-head quota of capital invested. This is what laissez-faire capitalism brings about to the extent that its operation is not sabotaged by government and labor unions.

Money is the commonly used medium of exchange. It is a market phenomenon. Its sphere is that of business transacted by individuals or groups of individuals within a society based on private ownership of the means of production and the division of labor.

Where there is no market, there is no money either.

What is needed first of all is to force the rulers to spend only what, by virtue of duly promulgated laws, they have collected as taxes. Whether governments should borrow from the public at all and, if so, to what extent are questions that are irrelevant to the treatment of monetary problems. The main thing is that the government should no longer be in a position to increase the quantity of money in circulation and the amount of checkbook money not fully—that is, 100 percent—covered by deposits paid in by the public. No backdoor must be left open where inflation can slip in. No emergency can justify a return to inflation. Inflation can provide neither the weapons a nation needs to defend its independence nor the capital goods required for any project. It does not cure unsatisfactory conditions. It merely helps the rulers whose policies brought about the catastrophe to exculpate themselves.

One of the goals of the reform suggested is to explode and to kill forever the superstitious belief that governments and banks have the power to make the nation or individual citizens richer, out of nothing and without making anybody poorer. The shortsighted observer sees only the things the government has accomplished by spending the newly created money. He does not see the things the nonperformance of which provided the means for the government’s success. He fails to realize that inflation does not create additional goods but merely shifts wealth and income from some groups of people to others. He neglects, moreover, to take notice of the secondary effects of inflation: malinvestment and decumulation of capital.

Whatever the merits or demerits of this point of view may have been in older days, it is obvious that it is no longer of any consequence. The main inflationary motive of our day is the so-called full-employment policy, not the treasury’s incapacity to fill its empty vaults from sources other than bank loans. Monetary policy is regarded—wrongly, of course—as an instrument for keeping wage rates above the height they would have reached on an unhampered labor market. Credit expansion is subservient to the unions.